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Looking For a Turnaround: Sector Sentiment Run

Takeaway: August Materials Sector Sentiment Run

Our monthly sentiment run is a behavioral, market-based gauge of investor sentiment in the Basic Materials Sector. Any relative performance measure is tied to an S&P 500 Materials Sector INDEX (GICS or XLB). Further screening methodologies are included in the link to the tracker below.

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Click Here to access the associated slides. 

 

Key Call-Outs:

 

Positive Sentiment (or more positive)

Negative Sentiment (or more negative)

 

  • Short-Interest: Gold Miners remain among the least shorted. Month-over-month, short-interest has shifted back toward the chemical companies (basic, diversified, fertilizer). 8 of 12 of the highest short interest names are in the chemicals space if Ag. Chem is included (Mosaic (MOS) and CF Industries (CF) are among the top 12).
  • Buy Ratings: After a shifting and re-shifting of miner short-positioning, metals & miners have consistently had the lowest buy ratings in the sector in 2016 (VALE, FCX, FMG). Mosaic (MOS) and Yara (YARIY) are also in the top 12. 
  • Combining consensus “buy” ratings and short-interest, Construction Materials (VMC, MLM) have the most positive relative sentiment when combining both metrics. Sentiment in the chemicals space is mixed. Looking at the sub-sectors in aggregate, sentiment among specialty and diversified chemicals is relatively positive when combining short-interest and "buy" ratings despite 8 of 12 with the highest short-interest being chemical companies.
  • Earnings Season: Sales and earnings growth has come in -8.8% and -6.7% respectively for the 21 out of 27 Materials names in the S&P 500 that have reported. The one sub-sector that has comped higher Y/Y for Q2 (sales +7.3% and earnings +41.3%) is construction materials (VMC, MLM).  Q2 will likely mark the 4th consecutive quarter for negative earnings growth for S&P 500 materials constituents.
  • LOOKING FOR A TURNAROUND: However, past Q2 2016, consensus currently expects a sharp turnaround in sector earnings (+6.1% in Q3, +19.1% in Q4, 20.9% in Q1 2017, and 12.0% in Q2 2017), so today's current forward multiple, near a cycle peak, has in it a sharp expected earnings turnaround on the whole.   

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT)

Takeaway: Fed farmer credit data shows 1) Tightening credit indices; 2) A decline in repayment rates; And, 3) A deterioration in land values.

The big question that will be answered in the intermediate-term is the effect of credit contraction, repayment rates, and land values on farmer input consumption trends. As we’ve highlighted with our recent calls in the Ag. space, we believe a deterioration in these metrics will prove meaningful:

  • The Chicago Farm Loan Repayment Index contracted from 43 at the end of Q4 to 32 through Q1 (-44% Y/Y) while the Chicago Fed Farm Loan Demand Index increased to 156 from 134 through Q4 (+11% Y/Y) – The Chicago Fed Fund Loan Availability Index was flat Y/Y.
  • The Kansas City Fed Loan Demand Index (nominal USD) is +6.2% Y/Y through Q1 and the Kansas City Fed Farm Income Index (nominal USD) is -73% Y/Y.
  • The Federal Reserve Bank of Chicago 7th District measurement of farmland values shows that farmland values are down -4% Y/Y, the largest rate of deceleration since Q3 of 2009. Cash rental rates for the 7th district are down -10% Y/Y.
  • Without having received updated data on past due real estate loans secured by farmland, loans 30-89 days past due were up 33% Y/Y through Q4, and there is no evidence to suggest a reversal in this trend.  

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - Chicago Fed Credit Indices

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - Chicago Fed Farmland Valuespng

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - KC Fed Credit Metrics

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - 30 89 Days Past Due Real Estate Loans Secured By Farmland

 

 


Earnings & Expectations - Key Call-Outs (Peak Forward Multiples)

The Materials sector, and the S&P 500 as a whole, is going on its third consecutive quarter of negative Y/Y earnings growth, and forward expectations have been taken down (obviously on a lag). With the sector now trading at peak forward multiples, below we ask the question, are forward-looking earnings expectations now too beaten-down, or is the current peak multiple a sign to be cautious of prospective returns? We would argue the latter.

 

*Note*: The S&P 500 GICS Materials Index only has 27 companies, so we’ll take a deeper look at expectations and different multiples for a larger sample next week in our monthly “Sector Sentiment Run” slide deck.

  • Earnings Growth: With Materials sector earnings down -18% this reporting season to date (after printing -18% in Q4 2015), Q1 2016 would mark the 3rd consecutive quarter of negative Y/Y earnings growth (see chart below).
  • Case for Peak Multiples: Without question earnings expectations have been revised materially for the obvious reasons, especially in resource-driven sectors. Every sub-sector beat bottom line expectations in Q4 despite the fact that earnings declined -18% (the same level we are currently tracking for Q1 2016). With the 2-month move in Materials stocks, does the market have it right? – The sector is trading at cycle peak forward multiples. 
  • Earnings & Expectations: Earnings growth beat estimates by 16.9% in Q4 2015 despite declining -17.9%. However, every sub-sector beat top-line estimates in Q4. This trend has continued for Q1 2016. So are earnings expectations too low, or is earnings manufacturing by corporations at unprecedented levels? Either way, the sector is trading at a peak multiple 7 years into a bull market, which in reality could be a much higher on a comparative basis, and we question the catalyst to take the market to much higher multiples without a correction. Again, we’ll look at this next week with a larger sample of companies.

 

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - PE Chart

 

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q1 COmps

 

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q4 15 Comps

 

 


Jumping Beans - Key Call-Outs (SOYB, CORN, AGU)

Soybean market breadth has been strong on the CME – even unprecedented. Speculation behind the move has come from many different fundamental angles relieving U.S. farmers whether it be: 1) Brazilian farmers curbing forward-selling with political uncertainty; 2) Argentina unloading of record soybean stockpiles now being offset by unfavorable weather; 3) China shifting purchases from Argentina to the U.S.; 4) Macro - A weaker Dollar making U.S. crops more competitive in the global landscape.  

 

Whatever the correct story, the market has seen huge relative volumes and record levels of futures open interest behind the price move (some of it a structural change with ETFs holding futures contracts) off the end of February Lows with a huge long build in net futures and options positioning (table below), which we outlined in Monday’s call-outs. Implied vol. has spike triple digits (3-4x trailing averages in grains). See charts below for the behavioral set-up.

 

However, with regard to Y/Y farmer economics and FX moves (especially in the Real and Argentine Peso), we would need to see a sustained continuation in the short-term move before we would reconsider farmers’ beaten down propensity to consume crop input expenditures (fertilizer, seed, nutrients) in a time of credit contraction on the farm – farming realities move much slower than the CME, hence our thesis - the price of inputs has been slow to lag real-time grains prices out of the 2012 bubble highs, compressing farmer margins to dire straits. AGU’s retail exposure is more levered to the price of domestic corn, which like soybeans, is only up mid-single digits Y/Y against a U.S. dollar that is down -3.8% Y/Y. Continued unfavorable economics should weigh on the budgets of cash-strapped farmers who have gotten little relief in the price of seed, fertilizer, nutrients since the 2012 bubble highs in grains prices – YET – See last chart below.

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - Open interest

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - Avg. Volumes

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - price changes

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - Implied Vol

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - Contract Positioning

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - AGU Retail Exposure

 

Jumping Beans - Key Call-Outs (SOYB, CORN, AGU) - Seed Expenses 


Birds-Eye View: Key Call-Outs (AGU, CF, MON)

We presented the bear case on Agrium last Wednesday at 11:00 a.m. with a blackbook and conference call. To summarize, we believe the retail business is misunderstood and subject to short-termism from an analysis perspective. In our view operating margins in the retail business, which have been stable post-recession, will contract meaningfully as the sector continues its long cyclical downturn. Ping us back directly for the deck or related inquiry.

Aside from our core thesis, below we outline some important catalysts to watch from a global trade perspective that will have implications for the competitiveness and profitability of U.S. farmers:

  • EM FX Move: After a sharp EM currency move for the Brazilian Real and Argentine Peso, the currencies of the two largest soybean exporting countries have appreciated meaningfully against the USD since Jan-Feb lows, which should have implications for the profitability and competiveness of Argentine exports as they are now selling a record stockpile onto global markets in volumes not seen since 2012. Robust Chinese demand and a bout of rainy weather in Argentina is also helping support prices and bullish speculation on the CME.   
  • Brazil Factor: In Brazil, there is speculation on the direction of monetary policy and currency in particular should Rouseff be ousted (speculation for more hawkish policy from a new regime). With the lower house of congress voting to move forward with impeachment proceedings over the weekend, this appears more likely. Forward sales of commodities are reportedly being curbed significantly, and for soybeans specifically, this could shift some incremental buying to U.S. Markets: LINK
  • Long Bias in Soybeans: Aggregating net futures and options positioning from the CFTC shows a soybean market leaning +2.4x and +1.9x on a 6-mth and TTM z-score basis.
  • Fertilizer Rates: With muted application rates in the fall window, fertilizer prices and regional spreads have moved higher off the Jan. lows (urea and ammonia), with a jump in the Cornbelt/NOLA ammonia spread. Although volumes should come in strong Y/Y given the muted fall application season, prices are still down considerably Y/Y. As the last chart shows, we believe there is quite a bit of margin to lose on pricing after an unprecedented increase in money spent on crop input expenditures over the last several years. 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - FX

 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - Argentine Ending Stocks

 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - Argentine Exports

 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - CFTC Position Monitor

 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - Cornbelt NOLA ammonia spread

 

Birds-Eye View: Key Call-Outs (AGU, CF, MON) - Ferts Expenses

 

 


TROUBLE on the FARM – Key Call-Outs (MON, AGU, CF, MOS, POT)

Momentum in tighter credit standards for cash strapped farmers should continue to weigh on crop input expenditures. What we would call-out with respect to margins is that despite the consensus dour view on the sector, fertilizer companies still have a lot of margin to lose, something we will continue to highlight:

  • The divergence in the Chicago Fed Farm Loan Repayment Index and the Fed Farm Loan Demand Index continues its years-long divergence.
  • Farm Incomes (nominal and real) continue to decline against the increasing demand for loans. Lower incomes = credit needed. After last week’s quarterly WASDE report, the USDA’s Commodity Credit Corporation (CCC) tightened its borrowing rate-based charge for April to 0.625% vs. 0.50% in March. It also raised the interest rate for crop year commodity loans to 1.625%, up from 1.5% in March: LINK
  • Using the example of nitrogen, the multi-year divergence in nitrogen prices paid by farmers vs. prices received by farmers for crops remains pinned at the highs. The ammonia to nat. gas price ratio also remains near the most favorable level for producers – Margin to lose to a supply-side “price floor” argument.
  • How inelastic is the demand story in nitrogen? We’ll find out in 2016: “Randy Thompson plans to apply 30% less nitrogen fertilizer to his corn this year to save money in the face of crashing crop prices”: LINK

 

TROUBLE on the FARM – Key Call-Outs (MON, AGU, CF, MOS, POT) - Chicago Fed Farm Credit Indices

 

TROUBLE on the FARM – Key Call-Outs (MON, AGU, CF, MOS, POT) - Kansas City Farm Loan Demand Index

 

TROUBLE on the FARM – Key Call-Outs (MON, AGU, CF, MOS, POT) - Farmer Producer Price Index

 

TROUBLE on the FARM – Key Call-Outs (MON, AGU, CF, MOS, POT) - Ammonia Nat Gas Price Ratio

 

 


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